More interest rate cuts loom, but each will be a battle

If financial markets are right, there will be another December rate event this Thursday, with a cut from 4 to 3.75 per cent almost fully discounted. The MPC chose not to cut last month, despite a new forecast, but it was close: a 5-4 vote. Another split verdict is expected this week, but the markets think enough MPC members will cross the aisle to permit a reduction.

• Interest rates expected to fall after unemployment hits 5%

Friday’s weaker-than-expected GDP figures suggest that the markets are right to take that view. Until that release, many economists thought that a December rate cut was touch-and-go. Now, though the vote is still unlikely to be clear-cut, it will be hard for the Bank not to announce a reduction.
The monthly GDP figures, showing a 0.1 per cent drop in GDP in October against expectations of a 0.1 per cent rise, and a fall of 0.1 per cent over the latest rolling three months, after a rise of 0.1 per cent in the previous three, were poetic justice.

Economists had expected a bounce from the Jaguar Land Rover cyberattack to compensate for weakness elsewhere, some of which was clearly due to frantic pre-budget speculation. But the bounce was not strong enough, and only the weakness showed through. Having written here of the most chaotic budget build-up I can remember, it was gratifying to see that reflected in the official figures.

Having said that, there remain arguments against a cut, as I am sure we will see this week. Inflation is at 3.6 per cent and well above target. An interest rate cut to 3.75 per cent will leave a thin margin above inflation.

In addition, some of the recent weakness in the economy reflects pre-budget uncertainty, and the budget is behind us. Similarly, part of the softness in the labour market, which includes a rise in unemployment and fall in payroll numbers, may reflect structural factors such as the government-imposed increases in employment costs.

A worrying bit of news for the Bank on wage growth comes from Incomes Data Research, which monitors pay deals. It said recently that median private sector settlements rose to 3.4 per cent in the three months to October, with a third of deals above 4 per cent.

This debate was played out in public by two MPC members last week as Catherine Mann and Sir Dave Ramsden were required to submit annual reports to the Commons Treasury committee.

Mann, who is usually thought of as a Bank “hawk” but prefers to describe her approach as activist, thought last month that “inflation dynamics were unlikely to follow the rapid deceleration shown in the [Bank’s] baseline projection”. She thinks tight monetary policy is needed to lean against inflation and ensure a return to the 2 per cent target. Looking ahead, it would take a rapid deterioration in the employment outlook to change her view.

• Consumers ‘scarred’ by persistent inflation, says Catherine Mann

Ramsden, one of the Bank’s deputy governors, who voted to cut rates last month, thinks, in contrast, that “we can have increasing confidence that the currently restrictive level of the Bank rate will support the disinflation process, and bring headline inflation below 3 per cent by spring 2026 and back towards the 2 per cent target by 2027, in line with our central forecast”.

Ramsden’s view had plenty of caveats, and he said he will remain watchful for evidence that inflation is persisting rather than falling, including evidence that wage growth is too strong.

Now, without wanting to sound too much like the two-handed economist — “on the one hand, on the other hand” — both these arguments have merit. It is a tight decision, and the next MPC meeting after this week will not be until February 5.

I suspect the Bank will square the circle with what is known as a hawkish cut — in other words, reducing rates while also saying there is no guarantee of how many more are to come next year.

There was something similar when the Federal Reserve, America’s central bank, cut its official interest rate for the third time in the current sequence last Wednesday.

Markets, nonetheless, expect some further downward movement in US interest rates next year, and probably by slightly more than the Fed’s signal of just one more quarter-point reduction.

They are also likely to see that as being in prospect for the UK, however this week’s decision is framed. Rates are likely to be cut further, but each time there will be a battle and a close vote. The nearer we get to what the Bank thinks of as the neutral rate, which Ramsden says is roughly in the middle of a 2 to 4 per cent range, the bigger the debate on whether to cut.

This suggests that while it is reasonable to expect Bank rate to move down towards 3 per cent, or slightly above, it would take something unexpected — and for the economy, perhaps rather disastrous — to take us below that. One City firm has just revised up its low point for UK interest rates from 2.75 to 3 per cent.

Notwithstanding the coming MPC battles over whether and when to cut, official interest rates are likely to be at 3 per cent or slightly above it, say 3.25, in a year’s time. Then we will see the extent to which moving out of the recent period of relatively high rates (by the standards of the post-2008 period) can boost economic growth.

It may help, but the causes of weak growth go deeper. After all, most of the UK’s disappointing growth since 2008 occurred alongside near-zero official interest rates. The main benefit of lower rates would be as a signal that the high inflation that has dogged us for most of the 2020s is behind us — a moment that cannot come too soon.

PS

I have to report some supply chain issues — for jokes, that is. Not enough have been coming in, so there is just room for a smattering, right at the end. Instead, following my book recommendations, it has been suggested I should recommend some podcasts.

One of those suggestions came from the team behind the Economics in Ten podcast, which is indeed worth listening to. They describe it as “your go-to podcast if you want to learn about the lives, times and ideas of the world’s greatest economic thinkers”.

Over the years, I have had much to do with Ed Balls, the chancellor who never was, and George Osborne, who was chancellor for more than six years. Whoever paired them as what their Political Currency podcast describes as “frenemies” — at one time, you would not have thought there was much love lost between them — deserves much praise.

• Ed Balls and George Osborne: ‘Like us or not, we’ve been there’

There are plenty of others. Planet Money — “the economy explained, with stories and surprises” — is made by America’s National Public Radio. Closer to home, the BBC’s More or Less podcast, with Tim Harford, is excellent.

I don’t have an economic podcast to sell to you today. The Three Old Hacks one I sometimes do is not on economics and we have not done one for a while, though there’s one in the offing. I did do a recent podcast with my former colleague David Cracknell on the budget and its aftermath. You can find it by searching for Tavistock Talks.

Now for the smattering of jokes. David Lane sent in: “Everyone knows that the biggest mosque in the world is in Mecca, but very few know that the smallest one is in the capital city of Ecuador — it’s known as Mosquito!”

I apologise and have decided not to rerun the one from Jeff Wilner about a lawyer selling his soul to the devil and wondering what the fuss is about. You’ll thank me one day.

There’s just time for one from David Lewis: “I’ve opened a new restaurant called ‘The Lord Giveth’. I also do takeaway.”

More material gratefully received, as will be your recommendations for economic and business-related podcasts that you enjoy.

david.smith@sunday-times.co.uk